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RH Sees a Tougher 2019 Ahead

The luxury home furnishings retailer capped a good year, but investors are nervous looking forward.

It's not enough for a company to be successful for just a short while. Strong companies have to sustain that success year in and year out, navigating the ever-changing waters of economic conditions and finding ways to prosper regardless of the challenges they face. That's a task that luxury home furnishings retailer RH (NYSE:RH) has done well recently, turning the company around by transforming its business model and catering to a different base of core customers.

Coming into Thursday's fiscal fourth-quarter financial report, RH investors wanted to see the good times continue for the luxury retailer. RH's numbers for the holiday period were generally good, but the company's prediction that 2019 could be a lot tougher made some shareholders wonder if RH is up for the challenges that a slower economy might bring.

Image source: RH.

RH closes a strong 2018

RH's fourth-quarter results capped a record year for the retailer. Revenue was up just 0.1% to $670.9 million for the period, which was a bit more sluggish than most of those following the stock had anticipated. However, adjusted net income of $76 million soared more than 75% from year-earlier levels, and that produced adjusted earnings of $3 per share, topping the consensus forecast among investors for $2.85 per share.

RH's fundamental performance stayed generally strong. Comparable brand revenue rose 5%, and the primary reason for the flat sales figure overall was that the year-earlier period had an extra week that this year's fourth quarter didn't have. The company also celebrated cost-management efforts that had helped RH throughout the year, so that it boasted a 5-percentage-point boost in adjusted gross margin to 40.1% and a percentage point gain better than 5 in adjusted operating margin, to 12.1%.

Yet conditions deteriorated near the end of the holiday season as stock market volatility made RH's upscale customer base a bit less comfortable making big-ticket purchases. The retailer said that its core RH business saw sales decline of about 10 percentage points during the period from the third week of December through quarter end in early February. That cost the company about $13 million in revenue, causing RH to fall short of its own top-line guidance.

In the report CEO Gary Friedman highlighted the way the retailer has recovered. "Our focus on elevating the brand and architecting an integrated operating platform has resulted in our profit model leapfrogging past the home furnishings industry," Friedman said, "and RH becoming one of the few retailers that is expanding margins, increasing operating earnings, and driving significantly higher returns on invested capital." The CEO pointed to its differentiated corporate strategies as essential components of RH's success both now and in the future.

Why RH could see a slowdown

However, RH expects challenges ahead. Friedman pointed to "continued weakness in our core business post the fourth quarter market volatility, the negative trends in the high end housing market, and our continued efforts to edit unprofitable and non-strategic businesses" as potential headwinds for the coming year.

That led the high-end home furnishings retailer to rein in its previous guidance for fiscal 2019. RH now believes that revenue will be between $2.585 billion and $2.635 billion, or 3% to 5% higher than its 2018 sales. That's about 6 percentage points lower than its initial guidance, and about half of that comes from economic trends, while the other half stems from its elimination of holiday business, fringe promotions, and the single-source import model for its rug business. RH's new profit guidance for $8.41 to $9.08 per share in adjusted earnings was similarly downbeat, down from the $9.30 to $10.70 per share that the company had initially projected.

RH investors weren't happy with that downgrade, and the stock plunged 16% in pre-market trading Friday following the late-Thursday announcement. In order to regain its positive momentum, RH will have to demonstrate that the market hiccup in December was an isolated event that won't have a long-term impact on customer spending patterns. Now that the market has recovered substantially, it's entirely possible that RH will have the spring season that it wanted all along.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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